WASHINGTON, D.C. - The chairman of the Federal Reserve says if lawmakers can't reach a deficit reduction deal by Friday the resulting mandatory budget cuts known as " the sequester" could become a case of too much, too soon for the fragile economic recovery.
"Congress and the administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run," Ben Bernanke said today. "Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget."
Testifying before the Senate Banking Committee, Bernanke cited the non-partisan Congressional Budget Office's estimates that should the full budget cuts take effect GDP growth would be curbed 0.6 percent by the end of the year. The Fed chair dismissed the suggestion by some members of Congress to allow the sequester to pass while redistributing cuts among individual programs and departments.
"I think the near-term effect on growth would not be substantially different if you did it that way," he said, adding any programs selected by lawmakers to avoid or go under the budget knife would likely be politically driven.
His appearance before the committee was part of a semi-annual report required of his agency to Congress, where he stated existing law is expected to narrow the share of the deficit to GDP from 7 to 2.5 percent by 2015.
Bernanke also addressed concerns over the ongoing government policy to keep short term interest rates for borrowers at a record low. Bernanke stated the low costs were vital to growing the economy and would continue, but acknowledged the future risk.
"Very low interest rates, if maintained for a considerable time, could impair financial stability," he said. "For example, portfolio managers dissatisfied with low returns may 'reach for yield' by taking on more credit risk, duration risk, or leverage. On the other hand, some risk-taking-such as when an entrepreneur takes out a loan to start a new business or an existing firm expands capacity-is a necessary element of a healthy economic recovery."
Low long-term rates have led to increased spending on durable goods such as automobiles and the housing market, he said.
One slightly testy exchange resulted from the otherwise subdued hearing when the Fed chair was questioned by lawmakers of both parties over the Fed's perceived slow progress eliminating the concept of banks that were "too big to fail."
Sen. Elizabeth Warren, D-Mass., cited a recent Bloomberg study that suggested large lenders were receiving an $83 billion "insurance program." The senator said corporations needed to give more of that money back to taxpayers.
"The big banks are getting a terrific break and the little banks are just getting smashed on this, they're not getting a break," she said.
Bernanke is expected to face the House Financial Services Committee tomorrow.